Indonesia Economic Quarterly: Continuing adjustment

The pace of adjustment in Indonesia’s economy and policy settings to weaker commodity prices and to tighter external financing intensified in the third quarter, with the Rupiah depreciating by 17 percent against the US Dollar and policymakers tightening monetary policy.

A moderation in domestic demand is well underway, feeding into output growth. The World Bank now projects GDP growth to slow to 5.6 percent in 2013 and 5.3 percent in 2014, compared with 6.2 percent in 2012.

This outlook of a moderate slowdown in growth to just above 5 percent depends on Indonesia avoiding more binding external financing pressures. This depends on global funding conditions remaining sufficiently supportive, and on how well Indonesia’s policies facilitate continued near-term adjustment, and support competitiveness and investment.

Policies in this time of continuing adjustment will continue to play a vital role, and should focus on the “3 R’s” – (1) responding, to facilitate more near-term adjustment through monetary and fiscal policy coordination and maintaining the flexibility of the exchange rate, (2) reducing uncertainty, through continued contingency planning and communication, and (3) refocusing policies to lift the sustainable growth rate, through follow-through on the August policy package, the implementation of “quick wins” for competitiveness, and continued progress on fiscal sector reforms.

With the cost of fuel subsidies still high, and sensitive to the level of the Rupiah and global oil prices, further reforms to the fuel subsidy system would better protect Indonesia from fiscal risks in the short term, as well as free up spending for vital long-term investments in infrastructure and social programs.

More efforts are needed to further diversify Indonesia’s exports and boost competitiveness in order to sustain a more rapid pace of growth and development. Not only would this help stimulate exports and encourage foreign direct investment, but also help raise longer-term employment and economic growth. In the near-term, improving international connectivity, such as through the logistics performance at Indonesia’s gateway Tanjung Priok port, can provide a welcome lift to competitiveness.

The level and quality of infrastructure spending remains a key determinant of long-term trade and growth performance, with low levels of spending in the 2001-2011 period estimated to have weighed materially on growth.

A big push on addressing infrastructure weaknesses, as well as enhancing education performance, for example through improvements in local governance, can help to support sustainable growth, and inclusive development, over the medium-term.